CNE Outlines Likely Consequences of Puerto Rico Default

The Center for a New Economy released a paper on the likely consequences of Puerto Rico’s default, authored by Sergio M. Marxuach, the Policy Director of the center.

The report is premised on several assumptions:

The government of Puerto Rico decides to prioritize the provision of essential government services over debt payments.

The Governor utilizes the powers granted to him by the Puerto Rico Emergency Moratorium and Financial Rehabilitation Act (“Act 21 of 2016”).

The validity of Act 21 is challenged on constitutional grounds, either in Puerto Rico or Federal Courts, and the Court enjoins enforcement of the Act while the case is heard on its merits.

Congress does not enact any legislation before July 1 granting Puerto Rico the authority to restructure its debt.

The government of Puerto Rico does not reach a forbearance agreement with its creditors.

Puerto Rico does not obtain short-term financing to rollover any of the of the July 1st maturities.

Further, the report acknowledges some facts:

Puerto Rico’s economy continues to contract.

Puerto Rico has lost 238,000 jobs, or 19.3%, not in the sense of some jobs ending while new ones develop, but as a net loss.

In spite of historic numbers of people leaving the Island, unemployment in Puerto Rico stands at nearly 12%, more than double the rate for the U.S. as a whole.

Puerto Rico has, in addition to public debt totaling over $70 billion, some $2 billion in unpaid responsibilities such as payments to suppliers, tax refunds, disbursements for public institutions of higher learning, and more.

The territory has already defaulted on four types of debt and is expected to default on July 1st, 2016, on the types of debt guaranteed under Puerto Rico’s constitution.

If Puerto Rico defaults in July, it will be the first time a state or territory has defaulted on default of “full faith and credit” bonds since Arkansas defaulted on debts in 1933, during the Great Depression.

Marxuach sees five areas in which the default could have consequences:

Healthcare

Puerto Rico, because of inequities in federal healthcare funding, pays nearly half of the cost of the public healthcare which is provided to nearly half of the population of the Island. Cuts in funding have already had severe consequences. Marxuach points out that insurance companies are waiting for weeks to approve life and death treatments such as chemotherapy for cancer, and medical professionals are giving up and leaving Puerto Rico because they are not being reiumbursed regularly for the treatments they provide. Hospitals and other healthcare facilities are limiting services and laying off support staff, and Puerto Rico was already experiencing a severe shortage of doctors.

The Zika virus has added to the stress on Puerto Rico’s healthcare system, and dengue fever and chikungunya, both serious problems in Puerto Rico in the summer, have not abated.

Education

Schools are already closing and committed funds are not being paid to colleges. A July default could put Puerto Rico in a very difficult position at the beginning of the school year.

The report also points out that Puerto Rico has a high proportion of students requiring special services, a number normally correlating with poverty, which is much higher in Puerto Rico than in any State. Federal requirements to meet special needs may conflict with the general needs of the schools.

Public safety

The report foresees problems meeting the costs of police and fire departments. The fuel supplies for the Police Department, Marxuach says, were already in danger of being cut off because the government was $10,000,000 in arrears on payments for the fuel. Presumably, if the courts require Puerto Rico to prioritize debt service, the ongoing daily costs of public safety will continue to be threatened.

Public pensions

As of June, 2014, Puerto Rico’s government pensions were $43.6 billion in the hole. Without a solution for this problem, some 165,000 retirees and their beneficiaries face uncertain futures.

Realistically, the government of Puerto Rico will still have to take responsibility for care of many of these individuals if they do not receive their pensions. Since the pensions pay only an average of $1,059 per month, any reduction in pension benefits would create significant hardship for pensioners.

However, Puerto Rico’s pension obligations are unsustainable in themselves. “Puerto Rico, collectively as a society, owes approximately two-thirds of its GNP to 10% of its population,” Marxuach syas. “Wealth transfers of this magnitude do not occur without serious political consequences.” Pensioners have been a strong voting bloc, but Puerto Rico’s taxpayers may be unwilling to make efforts to fund pensions they probably will not receive when their time comes, especially if large amounts of the Island’s funds continue to flow off the Island as debt service.

Migration

The people of Puerto Rico do not have to stay on the Island and accept further austerity measures if the courts insist on them, because they are U.S. citizens and can freely travel to the States. “In the event of a default, forcing Puerto Rico to repay all its debts would involve either large further tax increases or significant cuts in healthcare, education, public safety, other government services, and pensions,” says Marxuach. “Either way, the incentive to leave the island will be stronger—and the tax base (the people who earn income) will continue moving to the mainland United States.”

This, he points out, will make it impossible to to repay the debt. Fewer people to work and pay taxes will remain on the Island, so their quality of life will be even worse as their numbers dwindle and the load is shared among fewer people. Talk of Puerto Rico’s need to grow their economy is empty if the people continue to leave at the current rate.

Consequences could include not only the humanitarian crisis which is already developing, but also the possibility of social unrest and of a federal bailout which will be much more expensive than any scenario currently under consideration.

“The United States Army invaded Puerto Rico in 1898 and Congress granted citizenship to Puerto Ricans in 1917. Congress cannot simply pretend those events never happened and that Puerto Rico and its inhabitants do not exist,” Marxuarch concludes. “Under the current U.S. Constitutional framework, Congress has the obligation to make all needful rules and regulations respecting the territory of the United States, as well as the moral obligation to prevent the prolonged and unnecessary suffering of Puerto Rico’s 3.5 million U.S. citizens.”